What are options on debt default? Bad and worse

WASHINGTON — The federal government won’t automatically or immediately default next week if it hits the legal limit on debt without an agreement to raise it from Congress and the White House.

That’s not to say there won’t be consequences for failing to raise the so-called debt ceiling. Key voices in financial markets are warning Congress and the Obama administration the consequences could be dire. The stock market, which had been on a roll this year, has fallen steadily over the past two weeks on fears that Washington will do more economic harm.

But on the specific threat of the U.S. government defaulting on its obligations to bondholders, it wouldn’t necessarily occur immediately next week.

A lot depends on which of two paths the Obama administration takes should politicians lead the nation to the cliff’s edge. The administration could try to prioritize who gets paid first in the event that money runs dry, or it could decide to pay all creditors roughly 68 cents on the dollar as money comes in every day.

On or around Oct. 17, the government would have to pay its bills with whatever money is coming into government coffers on a daily basis. The Bipartisan Policy Center, a think tank with budget experts from both major political parties, thinks the U.S. government can count on about $10 billion to $15 billion a day of incoming tax revenue and other payments to the government to pay what’s owed to creditors, retirees and doctors in the Medicare system.

The most important payment, in terms of the creditworthiness of the U.S. government, is the interest on government bonds due to investors. And it would be almost a month before a payment is due that’s so large that daily income revenues couldn’t cover what’s owed.

According to the center’s estimates, the next interest payment due after Oct. 17 is about $6 billion, due on Oct. 31.

That would be within the range of expected daily incoming revenue. It’s not until Nov. 15 that interest payments stretch significantly above the day’s projected incoming revenue, making it impossible to make the interest payments and cover daily debts such as payroll. On that day, the government owes interest payments of about $29 billion. Some Republicans say the government can avoid default easily by just paying the top-priority bills such as interest on bonds plus Social Security.

There’s a catch, however. It’s not clear the plethora of government computer systems could prioritize who gets paid and when.

“We don’t know if they have the technical capability to do that,” said Shai Akabas, a senior policy analyst for the Bipartisan Policy Center. “Computer systems are not set up for that; it is not the modus operandi.”

Instead of paying 100 percent of some bills and 0 percent of others, a Treasury Department inspector general’s report following the last debt ceiling showdown concluded the government favored paying everyone across the board a reduced percentage based on how much it had coming in.

“You cannot pay some bills and not others and think somehow that the fact that you’re paying some bills protects you from a loss of creditworthiness,” Obama said Tuesday in a news conference.

After Oct. 17, incoming revenues to the federal government would cover about 68 percent of the bills. One option would be to slash spending by 32 percent, or more than $1 trillion. Economic researcher Ed Yardeni, in a note to investors Tuesday, said that while retirees would still be paid, such cuts would hit most of the services that government provides and “would leave us literally defenseless, and park-less.”

If the Treasury Department chose to pay bondholders at the expense of Social Security recipients and military pensioners, the rating agency Standard & Poor’s would not consider the U.S. government in default.

“Failure to pay or reduced payments on non-debt obligations, such as funds owed to government contractors or benefits recipients, would likely have negative economic impacts but would not be considered a default under our rating criteria,” John Piecuch, an S&P spokesman, told McClatchy.

If the government missed any bond payments because it couldn’t or wouldn’t prioritize who gets paid, it’s a different story.

“Should the government fail to service a debt obligation, we would lower the sovereign rating to ‘SD’ (selective default),” said Piecuch. “This designation indicates that the issuer, in this case the U.S. government, has failed to service one or more of its outstanding debt obligations, which include U.S. Treasury bills, notes and bonds.”